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Don't brook any exception to rights
April, 19th 2007
The pre-1960 position should be restored, as that alone will make the pre-emptive right of shareholders sacrosanct.

The universal experience is if a law provides for any exception, the exception soon becomes the norm.

This is increasingly becoming the case with Section 81 of the Companies Act, 1956, which when enacted sought to protect the existing shareholders' stakes by mandating offer of additional shares to them as a matter of right whenever a company sought to increase its capital.

The idea underpinning this mandate was a member should be allowed to be a 26 per cent shareholder at all times if he was the 26 per cent shareholder when he became a member.

It is perfectly all right for a member to spurn this right but the first right of rejection ought to be given to him not only to protect his control over the company which is the popular belief but to safeguard his economic rights as well.

But Parliament, for some inexplicable reasons, supplied the escape route in 1960 by allowing dilution, indeed negation, of this valuable right with 75 per cent majority or even with a simple majority.

The result is dwindling of rights issue with a concomitant increase in private placements, especially through the QIP (Qualified Institutional Placement) route and preferential allotments.

That subscribers to private placements, especially in a QIP, as well as subscribers in preferential allotments shell out what in SEBI's perception is a fair price is no consolation to the shareholders thus marginalised, principally because any increase in share capital has the potential to dilute both in terms of earnings per share and value of the share in the market.

Moreover, had a rights issue been made, all the existing shareholders would have got the right to subscribe to the additional shares on offer strictly in proportion to their existing holdings and those not interested could have en-cashed the offer by renouncing their rights for the right price.

Both the QIP and private placement mechanisms have given minority shareholders the short shrift, by denying them compensation for the dilution in their wealth.

Parliament should, therefore, go back to the pre-1960 position; that alone would make the pre-emptive right of shareholders sacrosanct. Anyone wanting to bypass the shareholders should not be allowed to do so easily he will have to compensate them first before he enters, or beefs up his stakes in, the company.

The one wanting to beef up his control ideally should use the creeping acquisition route, which any day is fairer than the private placement route because the former is done in the market at the prevailing market price without diluting the net worth or earnings per share of the company.

And if mobilising additional capital is the purpose, then those using the private placement route must be made to buy the rights of the shareholders wanting to renounce their entitlements.

That such exercise would be more time consuming and expensive is no ground for usurping the rights of the shareholders unable to withstand the onslaught of the majority and acquiesce rather tamely, willy-nilly.

S. Murlidharan
(The author is a Delhi-based chartered accountant.)

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